What’s in store at Nov 19 RBI board meet: No give & take, no solution

NEW DELHI: Differences between RBI and the government are now open in public and the central bank’s board meeting on November 19 is likely to reflect the uneasiness between the two over a host of issues including the economic capital framework, capital adequacy, stringent rules relating to prompt corrective action (PCA) and availability of liquidity for MSMEs.

Analysts say a middle ground is possible on the MSME liquidity crisis, but on other issues 100 per cent solution may not be possible.

The debate over how much reserve is good enough for RBI to meet financial emergencies and whether any cut in ‘surplus’ reserves can be used to support the economy is the biggest sore point.

Data suggests RBI held total assets Rs 36.17 lakh crore as of June 30, 2018. Reserves standing at 27 per cent of book (nearly Rs 9.5 lakh crore) are higher than the 18 per cent recommended by the Usha Thorat group in 2004. They are also higher compared with the median of 16 per cent for major central banks globally.

For calculation of excess reserves, the key items of interest on the liability side are contingency fund, asset development fund, currency and gold revaluation. Foreign and domestic investments, meanwhile, account for 90 per cent of RBI’s assets.

Here’s how the RBI balance sheet looks like:

Source: Kotak SecuritiesSource: Kotak SecuritiesSurplus reservesHow much reserve is in excess is a subjective issue, which varies on the degree of conservatism.

The argument on one side is that RBI necessarily needs to be conservative (strong enough balance sheet even in a black swan event), while on the other hand the argument would be that a central bank can always print money to provide support in an adverse situation and, hence, does not require excess reserves.

Contingency funds account for 7.1 per cent of RBI’s total book. It is far higher than the BRICS (ex-India) average of 2 per cent, says global brokerage BofaML.

There is no legal bar on Finance Ministry drawing down RBI's reserves beyond the annual surplus, as long as Delhi maintains Rs 5 crore reserve fund with the central bank under Sec 46 of RBI Act.

Sec 47 also requires RBI to transfer its annual surplus to the government, after provisions, but does not place any restriction on further transfers, it said.

BofaML expects RBI's board meeting to support rate-sensitives such as bonds, financials, real estate by addressing the liquidity crunch.

ET earlier this week reported that RBI may consider reducing cash reserve ratio (CRR) to ensure availability of bank credit, without giving in to the government demand for dilution of bank capital norms.

Govt clarifies intentThe government has denied media reports suggesting that it sought transfer of Rs 3.6 lakh crore from RBI, which would be one-third of the reserves, in a bid to meet its fiscal deficit target. Finance Ministry says it wants to discuss and fix an appropriate economic capital framework with the central bank.

The government sticks to its fiscal deficit target for the year at 3.3 per cent of GDP, Secretary of the Department of Economic Affairs Subhash Chandra Garg said on Monday.

That said, data showed India's fiscal deficit touched 95.3 per cent of full-year target in just six months of the financial year.

"I very much hope RBI’s independence will be retained, and Section 7 will not be resorted to," he said, adding, there cannot be 100 per cent agreement at the board on certain aspects, Rahul Bajaj of Bajaj Group told PTI.

He said nobody across the world disputes the need for autonomy and independence of regulatory bodies. “But that does not mean India can go to the dogs! (by starving the industry of funds),” said Bajaj.

What can RBI do?Sec 7(2) gives RBI full powers to do "all acts and things" subject to government directions, if any, under Sec 7(1). Besides, Sec 7(3) also empowers RBI governor and deputy governors with similar powers subject to RBI board regulations.

“The RBI Act further establishes the primacy of RBI board. But Sec 11(1) empowers Delhi to dismiss any individual member, including the governor. It is in case of dismissal of the whole board that Sec 30 requires the government to entrust ‘superintendentence’ of RBI to a designated agency and explain to Parliament within three months,” BofaML noted.

There are questions if RBI should make provisions to the contingency funds and pass on the entire surplus to the government and whether the central bank should reduce its reserves to adjust for the ‘excess’ provisions of past years, Kotak Securities said in a report.

Changes to PCA norms unlikelyA total of 11 public sector banks (PSBs) and one private bank are under the PCA framework. A comparison of India’s PAC framework with that of US FDIC framework suggests the latter is based more on constrained discretion rules against former’s more rule-based system.

“A comparison of Indian and US PCA framework reminds us of Ben Bernanke terminology (2003) of how constrained discretion rules might achieve the desired objective of monetary policy making, rather than a strict rule-based approach. Perhaps, the US PCA framework encompasses more learning by doing and, hence, more effective and less stringent,” SBI Economic Wing said in a report.

The report suggests while RBI’s PCA framework and provisioning requirements are more conservative, such an approach helps it withstand crisis and recognise problems early to ensure timely corrective measure.

RBI may seek to withdraw its nominees from the boards of public sector banks, if it is forced to loosen the framework, ET reported.

Debate over RBI’s independenceIn October, the RBI Deputy Governor Viral Acharya raised the issue of independence of the central bank.

He said risks of undermining the central bank’s independence are potentially catastrophic, a “self-goal” of sorts, as it can trigger a crisis of confidence in capital markets that are tapped by governments (and others in the economy) to run their finances.

He said governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution.

The remark came after the government exercised Sec 7 of RBI Act and sent letters of consultation to RBI regarding key issues.

The section involves two stages: first, consultation with the RBI governor and second, giving directions to the central bank in public interest.

BofaML expects the delay in RBI open market operations (OMO) has pushed up yields, and this along with FPI debt outflows and aggravating rupee depreciation are straining the credit market.

It expects RBI to step up OMO to Rs 50,000 crore a month between December and March to arrest further lending rate hikes.